High-priced stocks: Where is the denominator?

While talking to a friend of mine, Avnish last week, he casually asked: Is there any stock which you are considering buying? Since I have been following Bajaj Auto for a while and have invested in the company for its economic soundness, I told him that you may consider looking at Bajaj Auto. The first question which emerged was: What is the price of the stock? The stock was priced at INR 2,732 per share (Sept 4, 2018). His next question was: “It’s very expensive, can you suggest a low-priced stock?” – “Kuch kam mahanga hai kya?” I was startled by his perception & questions:

The denominator, i.e. earnings or cash flows underlying the price was not even considered. Looking at the numerator, i.e. stock price alone will only lead to faulty outcomes

Simple facts below will clear some myths for Bajaj Auto:

  • Average Net profit since the last 10 years: INR 3,000 crores
  • Net Profit / EPS for 2017-18: Net Profit: 3,931 crores │EPS: INR 145.80
  • Free Cash Flow to Equity Holders for FY 2017-18: INR 5,154 crores
  • Market Capitalization (as on Sept 4, 2018) @ INR 2,732 share: INR 79,048 crores
  • Price / Earnings (P/E): 20.1x
  • Price / FCFE: 15.3x

A company which has had an average Return on Equity at 44% since the last 10 years, without the use of leverage, average net profit and free cash flow of approximately INR 3,000 crs and INR 3,200 crores yearly respectively since the last 10 years is at least economically sound; i.e. its underlying / denominator is in place.  The company has earned INR 3,931 crores net profit (EPS: INR 145.80) in 2017-18 and is being valued at 20.1x from profitability perspective and 15.3x from cash flow perspective.

This is where a lot of people go wrong; after all, salary of a sales person is usually determined by the earnings and the cash flows he brings for his firm. Why is it different for stocks then?

Disclaimer: Please note that these are my personal views. I am NOT a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014. All investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action. 

 

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